Are You Risk-Averse, Risk-Neutral, or Risk-Seeking?

Are You Risk-Averse, Risk-Neutral, or Risk-Seeking?

comfort zoneAs a binary options trader, one of the most valuable things you can do is to inventory your personality and get to know yourself as an investor. The decisions we make are not random; they are driven by different aspects of who we are, what we want and need, and what we fear. The better you understand yourself, the clearer your decisions will become. Knowing whether you pursue risk or avoid it can help you understand mistakes you make and choose a trading system that suits you.

Are you a risk-seeker or a risk-avoider? You may instinctively know the answer to this question without having to think about it. This is likely only the case though if you fall near one extreme or the other. Risk-averse, risk-neutral, and risk-seeking are not three distinct categories. Rather they are a spectrum with infinite points in between. You might be a moderate or extreme risk taker, or a moderate or extreme risk-averse investor. Few people are 100% risk-neutral, but you may still find that category most closely describes your behavior.

To define these three areas of the spectrum, I will explain a common example.

Imagine that you are offered two options. Option 1 involves a guaranteed payout of a negotiable amount. Option 2 is a payout based on a coin toss. You have a 50/50 chance of winning. If you do, you receive $100. If you lose, you receive nothing.

You can group yourself under one of the risk headings based on what you would do in this situation.

  • Risk-averse: If you are a risk-averse investor, you will find yourself immediately leaning toward the guaranteed payment. Depending on just how risk-averse you are, you may immediately accept it without concerning yourself with the amount. After all, some money sure beats no money. You do not perceive this as a “nothing to lose” scenario, because the guaranteed payment is technically yours by right should you accept it. You stand to lose that account receivable if you choose Option 2. But you might consider accepting the coin toss depending on the amount of the guaranteed payment of Option 1. Someone who accepts a guaranteed payment of, say, $20, is more risk-averse than someone who will only accept the guaranteed payment if it is $45, and might otherwise choose the coin toss and risk losing.
  • Risk-seeking: If you are a risk seeker, you may naturally find yourself drawn to situations where you could win or lose. The idea of making it big appeals to you, even though you might also lose big. You would naturally lean toward Option 2, and the chance of winning $100. This is of course especially true of the guaranteed payment is low, but even if the guaranteed payment is $50, you would probably still go with the coin toss. Only if the guaranteed amount is greater than $50 would you consider accepting it. Someone who would choose the coin toss over the guaranteed payment if the guaranteed payment is $80 is significantly more risk-seeking than someone who would choose the coin toss if the guaranteed payment is only $55.
  • Risk-neutral: So what is a risk-neutral investor? As you might have guessed, a risk-neutral investor will make his or her decision mathematically. Say the payment were less than $50. If you are risk-neutral, you will choose the coin toss. If the payment is more than $50, you will choose the guaranteed payment. What if the guaranteed payment is exactly $50? According to economic definitions, a truly risk-neutral person would choose the guaranteed payment.

While reading these examples, if you tried to define yourself, you probably already have realized that these are not truly black-and-white definitions. You could fit roughly in the risk-neutral area while still being slightly averse or slightly risk-seeking. Likewise, you could be a risk seeker who leans toward neutrality, or a risk-avoider who tends toward neutrality as well. You also could have a measurable difference between instinct and behavior. You might for example be a natural risk-seeker who forces himself or herself to make more neutral decisions in order to live responsibly. Or you could be a natural risk-avoider who trains himself or herself to take more risks to get more out of life.

Another interesting way to think about this is to consider how you freeze up under pressure and how you handle outcomes. It may sound counterintuitive at first, but if you are someone who is adept at handling losses, you actually are probably risk-averse. Those who know how to handle losing trades curb their risk in order to manage those losing trades (generally by preventing them). But that means that you can actually struggle with situations that might produce large wins. Conversely, if you are a risk-seeker, you tend to be an optimist; you can imagine large gains, and you would have no problem handling them, but you probably do not know too much about managing significant losses.

Do You Fear Success?

Some people experience a “fear of success.” I have read a lot of theories on what this is and where it stems from. Many people find it positively baffling, but as someone who has experienced it, I feel it is quite understandable and believe that it is oftentimes tied to risk behaviors. Of course, the fear of success may stem from many different concerns. You might be afraid of the changes that success could create in your life, or how other people will see you.

But maybe your fear of success actually is a reflection of your attitude toward risk. As a risk-averse person, I will often be terrified of an opportunity that could result in a big win. Why? Because I know that opportunities that carry big wins also tend to carry major risk, so I freeze up in these situations. I know how to manage losses, and that is by avoiding them—or so I think. Of course, this is something of a fallacy, and can prevent me from pursuing a great opportunity.

A risk-averse person in the same situation would typically do the opposite. He or she would not freeze up under the pressure of a huge potential gain, and would only freeze up if the situation went badly. Not knowing how to handle a huge loss, a risk-seeker will often react emotionally and either stop trading altogether or start chasing losses, still imagining huge gains at the other end.

It is easy to see where both of these behaviors can quickly become problematic. For that reason, it is often in your best interest to seek a middle ground. If you are on either extreme end, you should try with your behavior to seek something closer to neutrality. That does not mean you ever have to become completely risk-neutral, but you want to get closer to risk-neutrality. There your decisions are more mathematical and less emotional.

Mathematically Manage Day-to-Day Risk with a Plan

One way you can behave in a more “neutral” fashion as a binary options trader is to have a plan to manage your money and take only the best trades. As an investor, you do not have the luxury of an Option 1 with a guaranteed payout. All of your trades could go either way, win or loss, which is why they are called “binary” options, after all. But you never want to take a trade that is a genuine coin toss, and in that sense, you actually want to lean toward risk-averse behavior. The “neutral” here comes down to your emotional stability, and not to the specific numbers. You need to be winning more than 50% of the time in order to stay profitable.

You have two main tools to manage your daily risk.

  • Your money management plan
  • Your trading system

These tools are simple but powerful, and can help you to manage your emotions and instincts so that you make smart, logical choices. Your trading system tells you when to trade, and your money management plan tells you how much to invest. The beauty of a great money management plan is that you never vary the percentage you invest; you always invest the same low percentage. This eliminates the possibility of huge gains or losses. Everything is small and manageable. This makes trading more approachable for both risk-averse and risk-seeking types.

It also encourages you to stick to your trading system rules. If you wager arbitrary amounts of money, you may find yourself investing smaller amounts on higher-risk trades and foolishly large amounts on lower-risk trades. You should be avoiding high-risk trades altogether and sticking with trades that are likely to win.

Is Trading Easier for Risk-Averse People?

This may make you wonder whether binary options trading is easier for risk-averse people (and risk-neutral people) and harder for risk-seeking people. Perhaps on a day-to-day basis, the answer to that question is yes. A risk-averse person will naturally avoid so-so trades and stick only with the best setups, and will feel safer risking small amounts of money. A risk-seeker will really struggle with all of this, and will have to take extra steps to curb bad behavior.

That does not mean that binary options trading is easier overall for risk-averse traders, though. There is a big picture to look at as well. A risk-seeker may find it harder to invest when it comes time to actually sit down and do it, but may have a much easier time pursuing binary options trading as a career. A risk-averse person may struggle with the idea of a high-risk activity like trading. Risk-averse investors often feel more comfortable with low-risk investments like CD accounts, treasury bonds, and life insurance. Of course, none of these offer the possibility of a huge payout over time, and that comes back to what I was talking about earlier. Risk-averse investors can really struggle with fear of success. None of these investments offer success, but they do not offer a whole lot else either.

Bring Together the Best of Both Worlds for Success

Once you know whether you tend to avoid risk or pursue it, you have a much better idea of what is driving your decisions. These including your overarching decisions (like pursuing binary options trading for a living or not), as well as your daily decisions (like whether to take a given trade or avoid it).

While both the extremes could be considered objectively as “bad” places to be, the entire middle ground offers an area where you could feasibly become successful. Your goal is to select behaviors which contribute to that success, whether they feel natural to you or not, in a way that feels balanced and right for you. You may sometimes have to step outside your comfort zone to do this. Over time, though, you may discover that process becomes rewarding as well.

If you are a risk-seeker, be grateful for the part of you that drives you to invest in the binary options market—but beware of the dangerous temptation to invest on specific trades you shouldn’t. If you are risk-averse, try and overcome the overarching hurdles that make you want to steer away from “high risk” investment markets like binary options altogether. Take courage from the fact that your risk-averse behaviors will likely serve you well in making smart daily choices once you do start trading.

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